Asia Moves to Tighten Tax Net

Japan isn’t the only country in Asia wrestling with the repercussions of VAT, or value-added tax.

Japan on Tuesday raised its consumption tax to 8% from 5%, the first of a two-step increase that will push the tax to 10% by 2015. China, meanwhile, is expanding itsown VAT as part of broader tax reform, while Malaysia plans to impose a new VAT next year, part of what accountants say is a global shift from direct income taxes to this more controversial form of indirect taxation.

VAT generates debate because it is a so-called regressive tax, which because it applies a flat rate across all taxpayers imposes a larger relative burden on poor people and smaller businesses than it does on the rich or large corporations. Income tax rates, by contrast, typically rise with incomes and so are considered progressive.

VAT is becoming increasingly popular among governments because it is considered simpler to administer and less prone to evasion and fraud. This issue is particularly important to governments in developing Asia, where the Asian Development Bank estimates that tax revenue in the 2000s was on average just 17.8% of GDP, well below the global average of 28.6%, providing less money for sorely needed anti-poverty programs and public infrastructure.

In a report published this week, the ADB advised governments in Asia to either adopt VAT or improve existing VAT regimes. To offset the regressive nature of the tax, it said, governments should consider exempting small businesses and earmark tax proceeds for programs like education and healthcare that benefit society’s less-privileged segments.

Japan’s VAT is, even after the increase, one of the lowest in the developed world. At 8% it ties with Switzerland as the second-lowest among OECD nations, behind Canada.

The increase is designed to help whittle down government debt that has ballooned to more than 240% of GDP. The concern among economists is that the increase will hit household consumption and undo what the government has accomplished in reviving growth.

Since his election in late 2012, Prime Minister Shinzo Abe has pushed a combination of low interest rates and increased public spending in hopes of getting both companies and consumers to start spending more. Households in Japan have indeed been spending more, but largely to stock up before the higher tax hit.

Consumer spending typically returns to normal over time, but only after a lull. In April 1997, when the government last raised the sales tax, to 5% from 3%, consumption dived and –combined with the effects of the Asian financial crisis — pushed Japan into a recession. Izumi Devalier, an economist at HSBC in Hong Kong, predicts the latest tax hike will help halve growth in private consumption this year to 0.9%, from 1.9% in 2013.

VAT also applies to companies, which can pass on some, but not all, of the tax burden to customers. To help offset that impact, Mr. Abe’s government let the corporate tax rate fall to 36% from 38% and has assembled a 5.5 trillion yen ($54 billion) spending package.

Raising VAT has an important advantage over income tax hikes in Japan, where an increasing proportion of the workforce is retiring and has no wage to tax. When Singapore raised its own VAT to 7% from 5% in 2007, it enabled the country to better capture taxes from wealthy immigrants lured to the island-state by low income taxes that excludes income earned outside the country. It offset the impact on poorer citizens with rebates.

Malaysian Prime Minister Najib Razak announced last October that his country would bring in a VAT in 2015. It will try to reduce the regressive aspects of the tax by exempting basic food and transportation. Malaysia’s VAT also will be accompanied by cuts in personal and corporate income taxes.

While small business have complained that the paperwork the new tax brings ends up raising their tax bill, economists say it appears to be working. HSBC estimates the tax changes in China will represent a nationwide tax cut of between 300 billion yuan ($48.6 billion) and 400 billion yuan this year, or up to 0.5% of GDP.

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